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State Corporate Tax-Cut Proposals Offer False Hope

September 14, 2010 at 1:22 PM

A number of 2010 gubernatorial candidates propose to reduce or eliminate their state’s corporate income tax, saying this will stimulate growth and create jobs.  But, while states are understandably eager to get their economies moving again, corporate tax cuts will not likely work. Among the most important reasons why:

  • The resulting budget cuts or other tax increases would cancel the short-term stimulus. Unlike the federal government, states are required to balance their budgets.  So states must fully offset the revenue loss from corporate tax cuts.  That means some combination of cuts in services and increases in other taxes.  So even if corporations boosted a state’s economy by spending their entire tax cut in-state (which is very unlikely, as noted below), there would be no net stimulus.  The economy would lose as much as it gains.
  • Corporate tax cuts could even reduce the total amount of economic activity in the state. Some of corporations’ tax savings would likely go to their out-of-state shareholders in the form of higher dividends, which is good for the shareholders but of no value to the state that cut the taxes.  And some of the savings would go toward paying more federal income tax.  That’s because businesses can deduct their state corporate tax payments when calculating their federal corporate income taxes; a cut in state taxes means less to deduct, so higher federal taxes.  Meanwhile, the state revenue loss from the tax cut would likely mean lower public-sector spending on goods and services, nearly all of which is in-state.
  • Corporate tax cuts do little if anything to boost corporate investment over the long run. Numerous studies have found that cutting businesses’ total state and local tax bill by 10 percent would likely boost economic output and jobs by 2-3 percent.  But, since corporate income taxes account for less than 10 percent of total state and local business taxes in the vast majority of states, eliminating the corporate tax wouldn’t generate 2-3 percent more long-term growth. And, even these modest positive effects assume a state wouldn’t cut public services or increase other business taxes to offset the lost revenue. That’s unlikely, given states’ balanced-budget requirements.
  • Corporate tax cuts weaken long-term growth by leading to cuts in public services. Businesses need and demand high-quality education systems to produce skilled workers. They need well-functioning infrastructure to get their employees and supplies to their plants and their products to customers.  They need police and fire protection for their facilities, which need to be located in areas with good schools and recreation to attract senior managers, engineers, and other highly paid personnel.  If states help pay for corporate tax cuts in ways that impair the quality of these services, even the tax cuts’ modest positive potential impacts will not likely materialize.

The one recent example of a state eliminating its corporate income tax is Ohio, which phased out its tax from 2005 to 2009.  Despite a more than $1 billion annual reduction in business taxes, Ohio’s shares of national income, employment, and investment have all fallen since 2005.


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